Business Law

Artesenias Real Hacienda S.A. v. North Mill Capital LLC (In re Wilton Armetale, Inc.) (3rd Cir.)

The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:

SUMMARY

In Artesenias Real Hacienda S.A. v. North Mill Capital, LLC (In re Wilton Armetale, Inc.), ___ F.3d ___, 2020 U.S. App. LEXIS 24487 (3d Cir. August 4, 2020) (“Artesenias”), the United States Court of Appeals for the Third Circuit (the “Third Circuit”) held that a creditor’s prepetition avoidance claim, which had become property of the bankruptcy estate because it alleged a generalized harm to the debtor from which the creditor’s specific injury flowed, reverted to the creditor when abandoned by the Chapter 7 trustee.

The Artesenias opinion can be found here.

FACTS

Artesenias sued Wilton and its owner-guarantor for breach of contract. It got a $900,000 judgment. The owner transferred his shares in Wilton to Artesenias; Artesenias also recorded a judgment lien against a valuable warehouse Wilton owned. In the meantime, the former owner and another Wilton creditor, North Mill, with the help of Wilton’s counsel, looted Wilton to protect against Artesenias’s judgment and enrich themselves.

Artesenias later learned of the looting scheme. Artesenias sued the former owner, Wilton’s counsel and North Mill in federal district court. Shortly thereafter, Wilton filed a Chapter 7 bankruptcy. Under the Bankruptcy Code (the “Code”) Artesenias’s creditor’s rights action became property of the bankruptcy estate and subject to the bankruptcy trustee’s control for benefit of the bankruptcy estate and its creditors generally, with Artesenias’s action stayed by the automatic stay because it would interfere with the estate’s rights. When the trustee tried to sell the warehouse, Artesenias and North Mill fought over their competing lien claims to the proceeds of any sale. To enable him to sell the warehouse, the trustee entered separate settlements with each of them. Among other terms, the settlements both released the trustee’s claims against North Mill and its co-conspirators, but also expressly disclaimed any effect on any claims that Artesenias had against North Mill or the other defendants in the district court action. The bankruptcy court approved the settlement.

Towards the end of the Wilton bankruptcy, the bankruptcy court approved the trustee’s motion under Code section 554 to abandon some of the claims he still controlled. Among them were Artesenias’s claims against North Mill and the others in the district court. When Artesenias later resumed the litigation it previously had filed, the defendants moved to dismiss. Instead of ruling, the district court referred the matter to the bankruptcy court on the grounds that Artesenias’s claims were “related to” the bankruptcy.

The bankruptcy court dismissed the action on the grounds that only the trustee had “standing” to prosecute the claims, disagreeing that its abandonment order returned the claims to Artesenias’s control. On appeal, the district court affirmed, finding that the abandonment order returned the claims to Wilton. The Third Circuit reversed.

REASONING

The first key to the Third Circuit’s decision was its distinction between “constitutional” standing and “statutory” or “prudential” standing. Constitutional standing concerns what kinds of disputes are appropriate for the federal courts to resolve. Article III of the United States Constitution requires that for there to be constitutional standing, there must be a justiciable “case” or “controversy”. In Lexmark Int’l, Inc. v. Static Control Components, Inc., 572 U.S. 118, 125(2015), the Supreme Court delineated three criteria for constitutional standing: (1) “a concrete and particularized injury in fact”; (2) the injury is “fairly traceable” to the defendant’s actions; and (3) a “favorable” decision would “likely” cure the injury. In essence, this is a question whether the matter is the kind of dispute the Constitution authorizes federal courts to resolve.

Federal statutory or prudential standing (which I will call “party standing”) concerns whether a party which has a dispute that nominally comes within constitutional standing is entitled to seek relief in federal court. Not everyone who has somehow suffered an injury attributable to the conduct of another has a right to relief. Statutes are one way that such rights are created (another is the federal common law, though it is a limited source).

The Third Circuit had no difficulty concluding that Artesenias had constitutional standing. If its allegations were true, there is no doubt that it was injured by the conspiracy that left Wilton without assets from which Artesenias could satisfy its judgment. As the Third Circuit said, Artesenias’s alleged injury was “indirectly, but fairly traceable” to the looting, indirectly because the looting directly injured Wilton itself.

Thus, the question became whether it had party standing. When it filed suit, it evidently did, though that issue had not been adjudicated in the district court litigation when the bankruptcy commenced. But the filing of the bankruptcy changed that. According to the Third Circuit, all claims for direct injury to the debtor become bankruptcy estate property subject to the exclusive control of a Chapter 7 trustee under Bankruptcy Code section 541 and some related provisions. These provisions transfer to the estate and trustee all claims that: (1) existed before the bankruptcy was filed; and (2) that the debtor itself could have filed. The claims therefore by statute became estate property under sole control of the trustee until and unless he either disposed of them (by, e.g., prosecuting them to judgment, settled them or sold them) or he abandoned them by motion approved by the bankruptcy court or by failing to dispose of them by the closing of the case.

Artesenias’s claims were among those the estate thus acquired by statute. They stemmed from the looting of Wilton, that is, from direct injury to Wilton for which Wilton itself had claims; Artesenias’s claims were indirect, “derivative” of or “secondary” to the harm done Wilton. The injury done Artesenias was no different in kind than the injury done to other Wilton creditors by the looting of Wilton. But the transfer of party standing did not deprive Artesenias of constitutional standing. And Artesenias re-acquired its party standing because the trustee’s settlements with Artesenias and the defendants expressly excluded the Artesenias claims transferred to the trustee and the trustee later abandoned them.

The Third Circuit observed abandoned claims generally revert to their prior owner. That was Artesenias, even if its claims were related to Wilton’s claims against the defendants for looting. Nevertheless, the bankruptcy court’s abandonment order was ambiguous about where the claims went, sometimes identifying Wilton, sometimes Artesenias and sometimes Wilton-or-Artesenias. The district court’s opinion chose to resolve the ambiguity in Wilton’s favor. But the Third Circuit concluded otherwise. It relied in part on a provision that required Artesenias to credit what it got from the bankruptcy as a creditor of Wilton against any later recovery against the defendants. This provision, the court found, only makes sense if the abandonment order selected Artesenias as the recipient of the abandoned claims against the defendants.

AUTHOR’S COMMENT

There no quarrel with the result or the opinion’s basic reasoning.

What is a little puzzling was the wrestling match over whether the abandoned claims went to Wilton or Artesenias. If Artesenias owned those claims to start with, that Wilton’s trustee took them over by statute because they were the offspring of damage to Wilton should not alter the normal outcome on abandonment: that the claims go back their former owner, which was Artesenias. Wilton had its own related but distinct claims. What amounts to transmutation of the Artesenias claim to estate property is not necessarily eternal. Instead, it is best seen as a temporary measure to benefit the estate and its creditors that ends if its prospects for such a benefit terminate with abandonment. The real problem appears to have been a poorly drafted abandonment order that created confusion by possibly naming Wilton as the recipient of Artesenias’s unused claims. But to the extent that order did anything other than return the claims to Artesenias, it was error since abandoned claims revert to the former owner. Perhaps the Third Circuit chose the long way around the problem because the abandonment order was by then final, so it could not be reviewed or reversed.

One further point to consider is that the rule of Artesenias probably applies to the fate of state law fraudulent conveyance claims that were effectively assigned to the estate by Code section 544(b) as a means of augmenting the estate’s assets to the exclusion of parties that might have held such claims upon the bankruptcy’s filing. If the estate does not administer those claims, any held by individual creditors prepetition probably also revert to them.

These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.

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